There is an old saw that posits that good things and bad things both come in threes. Well, the Internal Revenue Service (IRS) has debunked that old adage by releasing Notice 2011-53 on July 14, 2011. The first two IRS releases addressing the implementation of the Foreign Account Tax Compliance Act (FATCA), Notice 2010-60 and Notice 2011-34, contained detailed procedures for foreign financial institutions (FFIs) to implement and comply with Sections 1471 through 1474 of the Internal Revenue Code of 1986, as amended (the "Code"). Most interested parties did not consider either Notice to be good news and many affected parties responded to these Notices by asking for leniency in the implementation of the FATCA withholding rules. The IRS took those comments seriously and in Notice 2011-53 provided a delayed timetable for the implementation of the FATCA withholding rules applicable to foreign financial institutions ("FFIs"). This is clearly very good news.

There is uncertainty, however, as to whether the IRS will extend the effective date for withholding that would be applicable to non-financial foreign entities ("NFFEs") that do not meet the requirements for a withholding waiver. Our contacts at the IRS tell us that the IRS will address this issue shortly.

I. Brief FATCA Background

The FATCA provisions contain an extraordinary set of penalty tax rules on FFIs that do not (i) conduct due diligence on their account holders, equity holders and debt holders to ferret out U.S. persons that are holding assets outside of the United States and (ii) disclose the identity of such persons to the IRS.1 Specifically, if the FFI does not comply with the FATCA rules, then "withholdable payments" to it for its own account and on behalf of its customers are subject to U.S. federal income tax withholding.2 Withholdable payments include items of U.S.-source income, such as interest and dividends, as well as gross proceeds "from the disposition of any property of a type which produce interest or dividends from sources within the United States."3 If the payment is made is for the account of a non-participating FFI, "no credit or refund shall be allowed or paid with respect to such tax."4 In other words, if an FFI does not comply with the FATCA rules, it will be subjected to gross proceeds withholding on its U.S.-source income and gross proceeds and will not be able to recover the withheld amounts.

II. Statutory Effective Dates

The legislation enacting the FATCA provisions are effective for payments made after December 31, 2012. Such legislation provides, however, that payments made on obligations outstanding on March 18, 2012 are not subject to FATCA. Section I of Notice 2010-60 provides that grandfather protection will not be afforded to equity investments "or any legal agreement that lacks a definitive expiration or term." Neither Notice 2010-60 nor Notice 2011-53, however, provided any phase-in for the FATCA provisions, and FFIs were anticipating that the FATCA withholding rules would simply apply to affected payments beginning in 2013.

III. Notice 2011-53 Defers the Dates by Which FATCA Withholding Will Apply for Payments to FFIs

A. Withholding Obligations

The single most important announcement in Notice 2011-53 is that withholding agents will not be required to withhold any amounts under FATCA (now commonly referred to as Chapter 4 withholding) with respect to payments made prior to January 1, 2014 for payments to FFIs. Beginning in 2014, withholding will be required on certain so-called "withholdable payments" made to non-compliant FFIs. Withholdable payments subject to withholding in 2014 include interest, dividends and other items of fixed or determinable annual or periodical ("FDAP") income. Beginning in 2015, withholding will be required on gross proceeds from the sale of stock or debt on payments to non-compliant FFIs.5 The IRS has not yet stated whether it will extend the date on which payments to NFFEs that do not meet the requirements for a withholding tax waiver will be required. If no further action is taken, prudent withholding agents, including FFIs, will be required to withhold on payments to noncompliant NFFEs beginning in 2013.

Passthru payments are both withholdable payments and payments that are attributable to withholdable payments.6 Only FFIs are subject to withholding on passthru payments. In Notice 2011-34, the IRS promulgated a controversial rule for determining whether a payment is attributable to a passthru payment. Under this controversial rule, a payment made by an FFI is treated as attributable to withholdable payments based upon a fraction, the numerator of which is the U.S. assets held by the FFI and the denominator of which is its worldwide assets. Under Notice 2011-53, withholding on passthru payments made to noncompliant foreign persons "will begin no earlier than January 1, 2015." As a result, FFIs will not be required to compute their passthru payment percentage until the first quarter of 2014.

B. FFI Registration

In light of the delayed effective date for FFI withholding, the IRS pushed back the timing for FFIs to register with the IRS. For FATCA purposes, FFIs are divided into two camps: (i) Participating FFIs and (ii) Non-Participating FFIs. Participating FFIs are those financial institutions that have agreed, by executing a written agreement with the IRS, to comply with the FATCA due diligence and reporting requirements. Non-Participating FFIs are non-U.S. financial institutions that have not agreed to do so. In Notice 2011-53, the IRS provided that FFIs may enter into FFI Agreements any time prior to January 1, 2014. Those that enter into FFI Agreements prior to July 1, 2013 (i) will be designated as Participating FFIs by January 1, 2014 and (ii) the FFI Agreements will be effective as of July 1, 2013. Those that enter into FFI Agreements after July 1, 2013 (x) will be treated as Participating FFIs by January 1, 2014, but may not be designated as such by that time and (y) will be treated as entering into their FFI Agreements on the date that the Agreement is actually entered into.

C. Due Diligence Requirements

Notice 2011-53 also delays the requirements for non-U.S. financial institutions to implement procedures to determine if an account is a U.S. account, that is, an account owned by U.S. persons or owned by a foreign entity that in turn is owned by U.S. persons.7 The date by which the due diligence must be completed will depend upon when the account was opened and the balance in the account.

  1. New Accounts. FFIs must conduct due diligence on accounts opened after the effective date of an FFI Agreement when the account is opened.
  2. Private Banking Account Balances with of $500,000 or More. FFIs must conduct due diligence on private banking accounts opened before the effective date of their FFI Agreements with balances of $500,000 or more on the effective date of their FFI Agreements within one year after such effective date.
  3. Private Banking Account Balances with of Less than $500,000. FFIs must conduct due diligence on private banking accounts opened before the effective date of their FFI Agreements with balances of less than $500,000 by the later of December 31, 2014 or one year after the effective date of their FFI Agreements.
  4. All Other Accounts. FFIs must conduct due diligence on accounts that are not described above within 2 years of the effective date of their FFI Agreement.

D. Reporting to the IRS

If the FFI has received an IRS Form W-9 from an account holder by June 30, 2014, the FFI must report the account to the IRS by September 30, 2014. For these accounts, the IRS has reduced the amount of information that must be reported in 2014 to information on the account holder, the account balance on December 31, 2013 and the account number. More robust reporting, in accordance with Notice 2011-34, will be required in subsequent years. If a U.S. account open in 2014 has not waived any reporting restrictions so that information can be reported to the IRS, the account must be treated as a recalcitrant account and must be reported to the IRS as such by September 30, 2014.

E. Clarification on Grandfathered Payments

As noted above, grandfathered payments include certain obligations outstanding on March 18, 2012. In Notice 2011-53, the IRS extended grandfather protection to any agreement that could produce passthru payments (determined based upon the issuer's passthru payment percentage). The IRS did not change its rule that agreements with no definitive terms, such as equity securities, are ineligible for grandfather protection.

Footnotes

1. See Code § 1471(d)(2) (financial accounts include depository accounts, custodial accounts and debt and equity investments in the FFI).

2. Code § 1471(a).

3. Code § 1473(1)(A).

4. Code § 1473(1)(A).

5. Code § 1473(1)(A).

6. Code § 1471(d)(7).

7. See Code § 1471(d)(1).

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.